Gazprom: Betting On High Dividend Yield And High Earnings Growth

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 |  About: PJSC Gazprom ADR (OGZPY), Includes: OIL
by: Katchum

Gazprom (OTCPK:OGZPY) is the world's largest gas business engaged in natural gas, gas condensate and oil prospecting, production, transmission, processing and marketing. The company operates both inside and outside Russia. I have been very bullish on Gazprom because the fundamentals of this company were very positive. You can read my previous analysis here. I noted that Gazprom was severely undervalued as the company traded at a P/E of 3.5, handed out a dividend of 2% and had a price to book value of 0.6. Since that article, the stock price of Gazprom has gone down 15% (Chart 1). I recognize that was a bad call. The decline has much to do with the worsening conditions in the eurozone.

So what has actually changed for Gazprom since January 2012?

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Chart 1: Gazprom (Micex)

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First off, Russian natural gas prices hasn't gone down since January 2012, it has basically been flat (Chart 2).

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Chart 2: Russian Natural Gas Price (U.S. dollar/thousands of cubic meters)

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On the other hand though, the Russian ruble has declined 10% since the start of 2012 (Chart 3) and has manifested itself in a decline of the stock price. This decline coincided with the biggest drop in oil prices since 2008. I discussed this decline in oil price in this article. Russia is famous because of its commodities and especially oil (NYSEARCA:OIL). So a decline in oil means bad news for Russia. That is also why the ruble has been weak. In the long run though, oil prices should continue to rise due to rising production costs. So it isn't a bad idea to buy into weakness here.

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Chart 3: USD/RUB Exchange Rate

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Now let's go over the company's fundamentals again. The P/E ratio has declined from 3.5 to 2.64. This means that the company's equity will rise 37% per annum, which is a pretty good return if you ask me. Next on, Russia has adopted a new policy of dividend payment for Russian state-controlled enterprises. These companies will now return 25% of their earnings into dividend payments. For Gazprom this means that you'll get 6% dividend per annum on your investment in the stock at this moment. The price to book value will continue to decline because the book value is rapidly increasing due to the low P/E ratio. Today, the P/B is at 0.49, which means the stock price should have been double today's value already.

These fundamentals are extremely positive and evidences a huge undervaluation in the stock price of Gazprom. The only possible reason for this undervaluation can lie in the prospective earnings of the company, the problems in Europe or the tax measures of the Russian government. But as we continue analyzing Gazprom, we will come to the conclusion that these aren't a problem either. I'll quickly discuss these in the following section.

The earnings of Gazprom are excellent. Their sales have been increasing 30% year over year (Chart 4). Net profit has also increased 30% year over year (Chart 5). This trend will continue in the future as global energy consumption is expected to grow 40% by 2030.

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Chart 4&5: Sales and Net Profit (RR BLN)

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The Russian share in Europe is only 27%, so a recession in Europe shouldn't be much of a problem.

As for the tax increases by the Russian government, you need to know that Russia isn't a country that imposes high taxes in the first place. In a previous analysis of mine on the effect of government intervention on the economy, I compared governments around the world and their tax rates. Russia came out as the country with the lowest personal income tax rate in the world. So it would be unreasonable to assume that taxes on corporations will be much higher. Today the mineral extraction tax rate is 509 rubles ($US 15.7) per thousand cubic meters, while the natural gas price is at $US 447/thousand cubic meters. This is basically a 3.5% tax rate on mineral extraction. This tax rate is going to double to 7% when reaching 2015. Income tax is around 20% so the extra 3.5% mineral extraction tax rate going forward isn't very significant. Gazprom estimates that its EBITDA will decline 10% due to this extra taxation. This 10% decline is more than offset by the increase in net profits due to higher sales.

Conclusion:

Gazprom has excellent fundamentals and an equally excellent future prospectus. Due to European problems and a decline in energy prices its share price has declined. This is a perfect opportunity to buy the dip as I believe taxation and recession worries are overblown. Considering the high 6% yield (new dividend policy of Russian government) on dividend payment, I rate Gazprom a buy. Certainly, I would rather be in Gazprom than in 10 year U.S. government bonds at 1.5% yield.

Disclosure: I am long OTCPK:OGZPY.